Amazon Shareholders: Your Best Move to Make Now
Last week, shares of Amazon.com (NSDQ: AMZN) climbed above the $2,000 level. For longtime shareholders, the good news is that AMZN has doubled in value over the past two years. For more recent investors, the bad news is that AMZN is only back to where it was last August.
If you own Amazon stock, you may be wondering if now is a good time to sell it. Below, I’ll explain how you can extract more value from your Amazon stock without having to make that difficult decision right now.
The argument for selling AMZN now is its rich valuation relative to its profitability. After all, the stock’s valuation exceeds 50 times forward earnings, more than triple the multiple for the S&P 500 index.
On the other hand, even at that valuation AMZN still has a PEG ratio of only 0.78. The PEG ratio compares the PER (price-to-earnings ratio) to the average annual growth rate in earnings over the past five years. A ratio of less than 1.0 is regarded as desirable since that means a company has been growing its earnings at a faster rate than the stock market is discounting them into the future.
Of course, there is no assurance that a company will be able to continue to grow earnings in the future at the same rate it has is in the past. At some point, a company the size of Amazon simply cannot gain enough market share or expand profit margins at a sufficient pace to justify such high multiples.
Focus on the Top Line
I believe that is now the case for Amazon. To be clear, the problem is not its ability to grow revenue. In 2018, Amazon increased annual sales by 30% over the previous year. That rate of growth is not atypical for a small company, but almost unheard of for one with a market cap approaching $1 trillion.
As Amazon expands into new markets, it can continue to grow top-line revenue at just about any rate it likes. Last year, Amazon paid $1 billion to acquire PillPack, an online prescription business. In 2017, Amazon bought grocer Whole Foods Market for nearly $14 billion.
However, converting those ambitious acquisitions into bottom line profits has proved elusive for Amazon. Its most profitable business unit, Amazon Web Services (AWS), has nothing to do with its core retail business.
For that reason, some analysts (including me) believe Amazon may soon spin off AWS as a separate entity to maximize shareholder value. That would also provide Amazon with more capital to pay down debt and acquire other businesses.
Past its Prime Days
The company’s most popular service is Amazon Prime, which provides its members with a variety of benefits including free shipping on most items and access to special discounts. This week, Amazon hosted its annual Prime Day sales extravaganza (which actually lasted for two days).
Historically, Prime Day has been a huge success for Amazon. In fact, the event is referred to as “Christmas in July” by the company, since it produces a large spike in sales over a short period of time.
Last year, total Prime Day sales were 74% more than in 2017 ($4.2 billion versus $2.4 billion), and 175% above the previous year’s amount ($1.5 billion). Notably, international sales provided the bulk of those gains.
It will be interesting to see to what degree the Trump administration’s tough stance on trade with China and Europe might impact those results this year. That’s one reason why Amazon extended the length of Prime Day from 36 hours last year to 48 hours this year.
For that reason alone, Amazon will most likely post another big gain in Prime Day sales this year. If so, that is the number the company will want stock market analysts to focus on instead of bottom-line profits.
Stuck in a Trading Range
Regardless, I don’t think the stock market will be fooled by a public relations gimmick like Prime Day much longer. In the greater scheme of things, it is a relatively small factor when evaluating Amazon’s overall performance.
To be sure, Amazon has been one of the all-time great stock market success stories. Over the past five years, it has delivered a 600% return to its grateful shareholders. Not many companies can make that claim.
But it appears to me that AMZN has entered into a trading range over the past 18 months of $1,500 – $2,000. At the same time, some of Amazon’s largest rivals including Target (NYSE: TGT) and Walmart (NYSE: WMT) have seen their share prices jump by nearly 50% as they have bolstered their online sales efforts.
Also not helping Amazon’s recent performance is its refusal to pay a dividend or repurchase its own stock. At some point, company founder and CEO Jeff Bezos may have to reconsider how Amazon’s cash flow is allocated between the company and its shareholders.
However, I don’t believe that day is coming soon, given the company’s huge financial commitment to its recently awarded “H2” regional headquarters planned for Washington DC and New York. That being the case, Amazon shareholders may be in for a long stretch of relatively paltry returns until those long-term construction projects have been completed.
We Got You Covered
If you own AMZN, now may be the right time to consider using an options strategy to enhance your returns, since there may not be much share price appreciation anytime soon. For example, a few days ago you could have sold a “covered call” on Amazon with a strike price of $2,000 that expires in January 2020 for a premium of $165.
If AMZN closes above $2,000 on expiration day, your shares would be called away from you at that price regardless of its actual value. Including the options premium, that would equate to more than an 8% gain in just six months.
If AMZN closes below $2,000 on expiration day, that option would not be exercised against you. That means you get to keep your stock in addition to pocketing the options premium.
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